Educational Articles

Dow-30 Earnings: Alcoa Inc. - Second Quarter 2013

Dominic B. Silva
| July 09, 2013

Alcoa (AA -Free Alcoa Stock Report), an aluminum manufacturer and Dow-30 component, posted mixed results during the second quarter. Sales of $5.85 billion fell below our $6.03 billion estimate, as well as the year-earlier tally of $5.96 billion. Unfavorable comparisons were due to a sharp correction in aluminum prices on the London Metal Exchange (LME) and capacity curtailments.

Weakness in the aluminum markets proved detrimental for Alcoa's upstream business, which is comprised of Alumina (which mines bauxite and processes it into the precursor for aluminum) and Primary Metals (smelts aluminum). Dour circumstances here mitigated overall strength in the downstream area. In particular, the Flat-rolled Products unit (makes sheets for car and airplane parts, as well as beverage cans) and Engineered Products and Solutions (manufactures automobile wheels, turbine blades, and aerospace fasteners) performed well and have bright futures. These factors led to share earnings of $0.07, which fell short of our dime estimate, but was above the lowered consensus.

A material increase in global aluminum supply, most notably from China, has resulted in nearly two years of flat or falling prices on the London Metal Exchange (LME). To make matters worse, while companies globally have announced nearly 1.5 million tons in capacity cuts, more than 5.0 million tons of new production are on pace to come online this year, with a major portion of this being Chinese based. Although many of that country's facilities are probably operating at unprofitable levels, likely state intervention (subsidies and/or favorable power contracts) has encouraged managers to maintain production lines.

Concurrently, growth in this metal's demand is apt to be comparatively less, as a slower-than-anticipated rebound in industrial activity looms large. China's consumption and manufacturing recovery appears to be moderating and Europe's debt problems, together, are dampening recovery prospects. Other emerging markets are displaying similar conditions. An ongoing build-up in capacity has led to mounting aluminum stockpiles in certain markets.

The ensuing fallout has been sluggishness in LME prices (recently $1,780 per ton). In all, the value of this metal has fallen less than 10% this year, but is down approximately 35% from the record of $2,800 set in 2011. During the same period, Alcoa's stock has been the worst performer of the Dow Jones Industrial Average, declining 15%.

Recently, Moody's Investors Services downgraded Alcoa's debt, followed by lowered outlooks by both Standard and Poor's and Fitch. Lower credit ratings ought to lead to higher-yielding debt, should the company decide to raise capital. Too, any refinancing initiatives will be more costly, in our view.

Chairman and CEO Klaus Kleinfeld remains steadfast in his goal to lower the company's cost. In 2012, it shuttered 531,000 tons, or 12% of its total production, which resulted in $1.3 billion in savings. Measures to cut expenses have resulted in substantial benefits, but forces outside its control are proving to be overwhelming. Accordingly, it is taking additional efficiency-boosting steps. This year, the producer could take out another 11% of its output, leading to expectations of $750 million in cost cuts. Much of the curtailments will probably occur at smelters dependent on oil as a source of energy. In the same vein, the impending completion of an $11 billion (740,000 ton) low cost facility in Saudi Arabia ought to help, enabling Alcoa to shutter much of its more expensive capacity.

Management continues to project 7% global aluminum demand growth for 2013, driven by a 9%-10% advance in the aerospace market, a 3%-8% gain in commercial transportation, 4%-5% growth for construction, and a 3%-5% advance for industrial gas turbine products. Moreover, its outlook is predicated on accelerating momentum within value-added products in the downstream area. To this end, Alcoa is investing to capitalize on growth opportunities here, with a keen eye on aluminum-lithium alloys and aluminum sheet for automotive production. Nevertheless, in light of overwhelming poor fundamentals that surround this shiny metal, we have tempered our 2013 sales and share-net estimates by $710 million and dime, to $23.30 billion and $0.35, respectively.

About The Company: Alcoa Inc., a Pennsylvania corporation, is a global leader in the production and management of primary aluminum, fabricated aluminum, and alumina combined. It supplies the aerospace, automotive, building and construction, commercial transportation, and industrial markets. It has more than 300 operating and sales locations in over 30 countries. Sales of aluminum and alumina account for more than three-fourths of Alcoa’s total revenues. It also produces nonaluminum products, such as precision castings and fasteners for the aerospace and industrial markets. Alcoa’s operations consist of four worldwide reportable segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions.

At the time of this writing, the author did not have positions in any of the companies mentioned.